FDMC4027 Financial Decision Making For Creative Projects And Events Strategic And Financial Decision Making (ACFI5022)

Coop Danmark A/S (“Coop.dk”) is contemplating introducing a new computer

system which it is believed will streamline its supply chain activities. The major

savings will occur due to the more efficient movement of goods between

suppliers, Coop.dk central depots and Coop.dk stores. The new system has

been proposed by staff at the Albertslund Head Office.

The initial investment in the computer project would require an outlay of DKK14.5

million. The following cash flows related to the project (in current terms) are then

predicted to arise over the next five years (which has been selected as a prudent

time span over which to build an investment model due to the obsolescence

factor of IT systems):

Year 1 2 3 4 5

Cash Savings (DKK million) 4.50 7.00 14.00 12.40 8.75

Cash Operational Outflows

(DKK million)

1.50 3.00 6.00 5.40 3.75

It is anticipated that over the next 5 years:

ï‚· Inflation on cash savings will be 6% per annum

ï‚· Inflation on cash outflows will be 4% per annum

ï‚· The general rate of inflation in the economy will be 5% per annum.

The central finance team predicts an annual tax rate of 28% on the net cash

flows over the 5 years and the team is aware that the investors will require an

overall after tax REAL rate of return of 10.5%.

Required:

a) Calculate the Net Present Value (NPV) and Internal Rate of Return (IRR)

of the proposed investment in the computer project, taking into account

the impact of inflation and taxation (there are no capital allowances

available and tax is payable in the year of the net cash flow). You should

also provide a brief comment on your answer indicating whether or not the

investment is financially worthwhile.b) Christine Jensen, a Manager at the Odense Head Office indicates that she

and her assistant, Santosh Kunwar (who studied finance at undergraduate

level) have been looking at an alternative computer project and which

confusingly, upon investigation, has a lower NPV and higher IRR, than the

Project recommended by the Albertslund Head Office. Therefore, they are

not sure how this is possible or which methodology they should follow.

You are required to provide a considered response to their query.

(15 marks)

Task 2

According to Hamilton (2004, p4), “The difference between a 15% discount rate

and a 14% discount rate can mean a difference in value conclusion of hundreds

of thousands of dollars…….the capital asset pricing model (CAPM) is among the

most widely used methods to estimate the cost of capital.”

With Hamilton‟s statement in mind you are required to address the following

scenario:

Coop.dk wants to expand but foresees little exponential growth in its current retail

activities. The company has, therefore, decided to utilise their ability to raise

funds and their cash generation ability to organically expand into the hotel

industry. Coop.dk feels that the market is open to a new participant and that

companies such as the Arp Hansen Hotel Group are not ready for a vibrant new

competitor.

The management team is well aware of the majority of the parameters for

building the investment appraisal model. They know the initial sum to be invested

and further predicted outlays within the time period of the model. They are also

able to forecast the operational cash flows which will arise from their expansion.

However, although they know the returns required by their investors within the

supermarket industry they are unsure of the appropriate returns within the hotel

industry.

They have, therefore, decided to utilise CAPM, as indicated by Hamilton, in order

to ascertain an appropriate cost of capital (discount factor) for this expansion

project. They have concerns as they are aware that the hotel industry is riskier

than their current supermarket activities. This can be seen by the fact that major

finance websites‟ estimates of the beta factor of Coop.dk-comparable companies

is 0.84 and that for Arp Hansen is estimated at 0.99.

ACFI5022—SFDM Referral Assignment, Due 10 August 2015 Page 3/4

Required:

a) Consider Hamilton‟s statement and provide a full rationale as to the

use of CAPM for the calculation of a risk-adjusted specific discount rate

and also provide an opinion as to why you think it is or is not an

appropriate use of CAPM.

(25 marks)

b) Calculate an appropriate cost of capital that Coop.dk could use for their

expansion into the hotel industry, by utilising CAPM. This must be

based on actual researched data.

You MUST clearly identify each step of the process that you are

undertaking and provide a FULL rationale for each step. In addition,

you must provide an explanation of any assumptions that you are

making and also provide a full reference for EVERY piece of data that

you use.

(25 marks)

Task 3

Instead of undertaking „organic‟ growth as indicated in Task 2, Coop.dk could

undertake the indicated growth by acquisition.

You are required to provide a critical analysis of the relative benefits of the two

types of growth (i.e. „organic‟ and acquisition) from Coop.dk‟s point of view, with

regard to the proposed expansion
1. Identify major areas of consideration when looking at financing an event.
2. Define the scope and structure of profit and identify where it can be derived from.
3. Explain the types of decisions and considerations an event manager would need to make in order to ensure their event is financially viable.
4. Outline the key characteristics and concepts of pricing and the tools to be used in determining the price of an event.